by Neil Irwin
Draghi received his economics PhD from MIT three years before Bernanke did, though the two didn’t know each other at the time. He’d helped prepare Italy to join the eurozone, ending its chronic high inflation and cementing his position among the most elite of Italian civil servants, the highly capable technocrats who keep their country running amid the seemingly perpetual instability of its elected governments. His fellow central bankers held him in sufficiently high regard that they named him chairman of the Financial Stability Board, a coordinating body for regulating risks to the global financial system.
The blots on his résumé, at least from the vantage point of European leaders weighing whether to name him ECB presidency, were two: He had spent three years as a vice chairman of Goldman Sachs, a politically toxic former employer in the aftermath of a financial crisis caused by giant global banks. (In the matter of the role Goldman played in helping Greece to hide the extent of its indebtedness, Draghi denied any personal involvement, and it began before he joined the firm.) And he was, of course, from one of the is in GIPSI, a nation that could soon find itself negotiating a rescue package. Could an Italian central banker have a hard time winning the confidence of the financially stronger countries that were footing the bill for the bailouts? Would “Super Mario,” as the press had taken to calling him, seem so super in Germany, Austria, or Finland?
The initial reaction in Germany was negative. “Please, not this Italian!” said the tabloid the Bild in a typically subtle headline. “Mamma mia, with Italians, inflation is a way of life, like tomato sauce with spaghetti.” The more grown-up Der Spiegel engaged in a softer form of national stereotyping by merely observing that the candidates from Finland and Luxembourg, in contrast to Draghi, “both come from orderly nations.” But Draghi courted media and political leaders in Germany and beyond, always emphasizing that preventing inflation was his foremost goal.
Given the existential threat to the euro he would inherit as ECB president, it wasn’t perhaps the most obvious thing to focus on, but it did the trick. With impressive endorsements from the financial world—twenty-nine of forty-five private economists surveyed by Reuters supported him—Draghi soon became the prohibitive favorite. Even the Bild came around to his side, by April publishing an illustration of Draghi wearing a Prussian helmet, writing that “at second glance it is clear that he’s rather German, indeed a proper Prussian.”
On May 11, Merkel announced that she had come to the same conclusion about Draghi. “He is very much in line with our ideas about stability and economic solidity,” she told Die Zeit. “Germany could support his candidacy.” Unspoken was the reality that she and her advisers didn’t really have any better options to put forward, at least none that could garner broad support across Europe. With Germany’s endorsement, Draghi sailed through the formal process of going before the European Parliament.
Trichet’s successor was in the wings, and the challenges he was to inherit were getting tougher.
• • •
Over the first decade of the euro’s history, some things didn’t change. Certain countries—Germany, Austria, Finland—were creditors, spending less than they produced and accumulating savings. Others—Greece, Portugal, Spain—were debtors, spending more than they produced and having to borrow to keep their economies going. In Greece, that borrowing funded lavish government spending. In Ireland and Spain, it funded real estate booms. In either case, it meant that a nation’s citizens became accustomed to a higher income than would be justified by what they were actually producing. They weren’t as rich as they thought they were, and one way or another, their incomes needed to come back in line with reality.
Normally that would happen in large part through currency movements. The Greek drachma would fall against the German mark. And suddenly, workers who were paid 10,000 drachma per week would have a lower real income, even as they received the same number of drachma in each paycheck. The workers might be a bit poorer, with less ability to buy gasoline or imported wine, but their relative income would match their relative productivity. Without government officials needing to do much of anything, competitive balance would have been restored.
With Germany and Greece both using the euro, however, imbalances would need to be righted some other way. One way would be for the ECB to ease monetary policy and aim for higher inflation than usual. If it allowed prices and wages to rise 4 or 5 percent a year in the creditor countries while wages were stagnant in the debtor countries, within a few years their relative wages would come back in line with fundamentals and growth could resume. But the ECB has never seriously entertained this option; it takes its goal of keeping inflation a bit below 2 percent seriously, and anti-inflation Germans would be aghast at seeing their prices rise 4 to 5 percent each year.
That leaves one other option: outright cuts to the pay of workers and pensioners in the debtor countries. That was the strategy Trichet and the ECB pursued. They called it internal devaluation: The debtor countries had to find a way—through cutting state salaries and pensions, renegotiating contracts with unions, and the like—to force wages downward. Within the troika, the ECB was the strongest advocate for wage cuts. Trichet himself broached the issue with senior Greek officials, pointing them to a chart of “unit labor costs” showing that Greek workers were paid too much relative to those in the rest of Europe.
The problem is, economic pain, perceived and actual, is much worse when an imbalance is corrected by cutting people’s wages directly instead of through a currency devaluation or inflation. Economists call it nominal wage rigidity. For reasons that seem deep-seated in the human psyche, people are much less unhappy if their pay stays the same while inflation reduces the value of their paycheck 5 percent than if their employer actually cuts their pay by 5 percent. Moreover, when a country is dealing with an overhang of debt, inflation makes it easier to pay off that debt, whereas deflation and cuts to wages make it harder. A single currency Europe combined with the ECB’s unwillingness to entertain higher-than-normal inflation ensured that the GIPSI countries would have to correct long-standing imbalances in the most painful way possible. And because that left them unable to manage their debt loads, it also left the financially stronger countries of Europe on the hook for bailouts.
Given the adjustment they had to make, the best that Europe’s more troubled economies could hope for was that the rest of the continent would go on a veritable economic boom. At least then there would be more demand for Greek olives, Italian wine, and Spanish vacation houses. In the spring of 2011, Trichet and the ECB prevented even that possibility.
Prices for oil and other commodities were rising in the early part of the year, partly because demand from China and other developing nations was rising and partly because of geopolitical instability in the Middle East. By March, overall eurozone inflation over the previous twelve months reached 2.6 percent, a bit above the 2 percent the ECB had targeted. Even as the GIPSI countries were grappling with double-digit unemployment, the economies of the more populous core of Europe—Germany, France, the Benelux nations—were actually holding up reasonably well.
Trichet steered the Governing Council at its early March meeting toward signaling an imminent interest rate increase. The group hiked its interest rate a quarter percentage point in April and again in July. At a time when numerous European countries were in what can only be called a depression, the ECB was tightening policy. Asked at his April press conference if the action would increase the stress on the peripheral countries, Trichet was almost dismissive. “I will only say that we are responsible for ensuring price stability for 331 million people, and all the decisions that we have taken since the very beginning of the euro, including today’s, have been designed to deliver price stability to 331 million people.”
Sorry, Spain, you’re out of luck.
In hindsight, those rate hikes in the spring and summer of 2011 might seem to be among the biggest monetary policy mistakes of the modern a
ge. But when regarded in relation to Trichet’s negotiating strategy, both within the ECB Governing Council and with other European leaders, they look somewhat better.
From the earliest days of the crisis, in 2007, Trichet had been determined to keep the bold, unconventional steps the ECB undertook to support the financial system distinct from its usual responsibility of monetary policy. Whereas Bernanke treated buying government bonds and interest rate adjustments as different weapons in the same arsenal, Trichet regarded them as designed for wholly different purposes—so much so that in the summer of 2008, as the ECB was lending to European banks with abandon, it was also raising interest rates to combat inflation.
This bought Trichet credibility among his fellow central bankers as well as political leaders. Weber and the Bundesbank, for example, were much more comfortable lending billions of euros to banks when they were confident that the ECB remained hypervigilant about inflation. The spring and summer 2011 rate hikes may have been justified by legitimate research on the risk of inflation, but the real reason for them was one Trichet would never acknowledge, even in private: They were the price he had to pay to maintain the credibility as an inflation fighter that would give him a freer hand to be a crisis fighter.
The votes were even unanimous: The nationals of Greece and Ireland and Portugal on the Governing Council endorsed the hikes. “We felt we needed to send a strong signal, and in that sense, it worked,” said one council member. “We felt we could reverse them easily in the fall if we were wrong.”
Meanwhile, political fissures within the eurozone were growing. The major fault lines emanated from the proposed European Stability Mechanism and what powers it would ultimately have. Could it buy the debt of a country under attack on the markets, as the ECB had done to this point? Trichet wanted it to—it seemed a more appropriate role for the fiscal policymakers across Europe than the central bank.
But the ugly new politics of the Northern European creditor nations were making their leaders reluctant to sign up for anything that would make them beholden to Southern European debtor countries in financial trouble, the promises of May 2010 notwithstanding. So at the March 2011 Governing Council meeting, the ECB elected to suspend the Securities Markets Programme—to stop buying the bonds of Ireland and Portugal on the open market. Trichet had seen the pattern: Elected leaders were inclined to act on behalf of a united Europe only when markets forced them to. So the ECB was going to sit back and let the markets do their job, however much pain it might cause in the meantime.
Trichet was playing chess, sacrificing his pawns in hopes of saving his queen. But it came at the cost of a European economy even less well positioned to withstand the forces threatening to rip it apart. If Trichet lost, it would be in spectacular fashion.
SEVENTEEN
The President of Europe
In early May 2011, Jean-Claude Juncker, the prime minister of Luxembourg, had organized a secret meeting. The finance ministers of the four biggest eurozone countries, plus their counterpart in Athens and Jean-Claude Trichet, were going to meet in his small country to try to figure out what to do about Greece. In his official request for a bailout the previous April, Greek prime minister George Papandreou had described his nation as a sinking ship—and now it seemed to be going under even faster. Over the past year, Greek unemployment had risen from 12.1 percent to 16.8 percent. The ten-year government-borrowing rate had shot from around 9 percent to 15 percent. Public debt had risen from 148 percent of GDP to more than 171 percent. In February, concurrent with a nationwide strike, 100,000 people had taken to the streets of the Greek capital to protest government approval of austerity measures. One banner unfurled outside of parliament read simply, “We are dying.”
The hope was that the Luxembourg meeting, with just a few influential decision makers in the room, and none of the public spectacle of formal meetings of the “Eurogroup,” with all twenty-seven European Union finance ministers and their staffs present, would be a place where those gathered might truly speak openly, with all possibilities on the table. It helped that the gathering was to take place where few news organizations have a bureau, making the odds of their being spotted coming and going relatively low.
That evening, Friday, May 6, Trichet was in the backseat of a sedan en route to the meeting when an aide’s BlackBerry buzzed. There was some bad news: The German news magazine Der Spiegel had caught wind of the meeting; just before 6 p.m., it had reported on its Web site that the top finance officials of Europe were gathering to discuss the possibility of Greece’s exiting the eurozone and reestablishing its own currency. German finance minister Wolfgang Schäuble, the story said, was going to argue against the idea. He’d come prepared with a ministry study that showed just how dire the risks would be to Greece, Germany, the European Central Bank, and the eurozone as a whole. The move would “seriously damage faith in the functioning of the euro zone” among international investors, the paper reportedly stated. And that “would lead to contagion.”
Trichet was furious. He had agreed to come only because the meeting was secret. A publicly announced gathering would create expectation in the markets that some major policy announcement was on the way—and commensurate disappointment and disruption if one wasn’t made. Juncker’s spokesperson denied to the press that there was any such meeting, later defending the lie by saying that “We had Wall Street open at that point in time,” so “there was a very good reason to deny that the meeting was taking place.”
In fact, the meeting was more about the touchy matter of reducing Greece’s debt load by restructuring its bonds than it was about the nation’s potential withdrawal from the eurozone. But the leak was emblematic of a broader problem in Europe’s response to the megacrisis. Ben Bernanke and Tim Geithner could speak privately whenever they wanted, with word of their conversations never leaking out. With seventeen finance ministers in the eurozone alone, details of the European talks were forever popping up in one country’s newspaper or another. And in an Internet age, what was printed in a newspaper in Berlin was known in the government offices of Paris and on the trading floors of London before the ink was dry.
When the meeting began, Trichet let the assembled officials know in no uncertain terms how irritated he was. “I cannot participate in a meeting advertised as private that then isn’t,” he said. “I have never seen anything like this in any country.” Trichet then refused to take part, left abruptly, and returned to Frankfurt.
The Greek economy, it seemed, wasn’t the only thing under strain.
A few days later, another troika higher-up would find his private actions made very much public. At 12:06 p.m. on Saturday, May 14, maid Nafissatou Diallo went into International Monetary Fund managing director Dominique Strauss-Kahn’s suite at the Sofitel, a French-owned luxury hotel on West 44th Street in midtown Manhattan. Nine minutes later, she left—after an encounter with Strauss-Khan that she described as a sexual assault and he would later call a noncriminal “moral failure.” At 12:26 p.m., Strauss-Kahn left the hotel, briskly making his way to brunch with his daughter and then to John F. Kennedy International Airport for Flight 23 to Paris—he had a meeting with German chancellor Angela Merkel scheduled for the next day.
At 4:40 p.m., Port Authority police approached Strauss-Kahn as his plane idled at the gate, on the pretext of returning a cell phone he’d left at the hotel in his abrupt exit. Instead, they took him into custody for questioning. Rumors of the apprehension began to appear on Twitter less than twenty minutes later. By 7:35 p.m., the New York Times Web site had posted what seems to be the first reliable report of the incident. One of the most powerful men in the world, the presumed next president of France, was in a cell at the New York Police Department’s Special Victims Unit in East Harlem—and would eventually be charged with multiple felonies, including committing a criminal sex act, attempted rape, and sexual abuse.
Strauss-Kahn soon resigned from the IMF to fight the charges, which were d
ropped when prosecutors lost confidence in Diallo’s credibility as a witness. Strauss-Kahn’s sexual appetites had gotten him in trouble three years earlier, when he’d had a brief—and reportedly coerced—affair with a subordinate at the IMF. But now his career was over, both as Socialist presidential hopeful and as one of the key decision makers in the eurozone crisis. The suddenness of his downfall, as well as its sheer tawdriness, stunned his fellow crisis fighters.
More substantively, it left Strauss-Kahn’s number two, John Lipsky, in charge of the IMF at what was becoming a crucial time for Greece. Lipsky, an American who was formerly a J.P. Morgan economist, was a thoughtful and respected veteran of managing debt crises. But he didn’t have the deep relationships with European leaders that Strauss-Kahn did, and he had already announced that he planned to retire later in the year, making him a short-timer.
It was a particularly bad time for a leadership vacuum at the IMF. Greece was failing to carry out many of the reforms it had promised as a condition of its bailout, and the troika was ready to get tough about it. “The view that seems to be taking hold is that the government program is not working,” said Poul Thomsen, the IMF representative in Greece, on May 18. “The program will not remain on track without a determined reinvigoration of structural reforms in the coming months. Unless we see this invigoration, I think the program will run off track.” Translation: We will withhold the next installments of aid payments, allowing Greece to go broke, unless the government steps up privatization and austerity.